Is The European QE really a slam dunk or is the market setting up for disappointment?
When confronted with the comments made by Christine Lagarde last week urging the ECB to cut the already generation low 0.25% European funds rate, “Super Mario” Draghi just gently dispatched her with a “thanks, but no thanks”.
While he certainly acknowledges the role the IMF has been having in determining the future of the Eurozone, it seems that he doesn’t want it to interfere with his role at the ECB.
Over the last few months, speculation about the ECB cutting on the current funds rate and unfolding its own incremental QE program has been growing in crescendo. Draghi has repeatedly stated that the ECB is prepared to take action, but that comes always qualified with an “if needed” disclaimer. The “if needed” element is open to debate, and it seems to some that the ECB is content at present to see how events unfold in the States with their own QE withdrawal and whether this, finally, takes the pressure of the strong Euro and allow the continent’s exports some long overdue relief.
In fact, the latest data released on the general price level points to a potential deflationary environment taking shape in Europe. This is something which is particularly problematic in countries presently engaged in massive austerity programmes like Spain & Greece.
The financial crisis decelerated price growth for a while, but then prices recovered to near the 2% long-term growth target defined by the ECB. Of course this was a continent wide average. Places like Greece and Portugal have experienced lower rates as austerity measures have taken hold in recent years and suppressed demand. However, even among the Northern European nations like Germany & France, price stability is now slipping and indeed prices are sinking everyday (or at least their growth rate is) with the latest data for March showing an advance of just 0.5% – a muted measure last seen right in the heart of the financial crisis.
The problem with Europe derives from essentially two sources. First of all, the austerity measures imposed by Germany in particular, and which has pressed for massive structural and political changes across peripheral Europe, has led to a drag on consumption expenses which in turn has pressed overall prices down. Additionally, fiscal tightening led to a rapid rise in unemployment levels, a reduction in disposable income, and of course, to a massive era of deleveraging.
Secondly, while the FED and the BOJ have been printing money 24hrs a day the ECB has, in contrast, been much more reluctant to cut on rates and engage in the same epic monetary easing. This could only led to an appreciation of the Euro. With import prices now being much lower due to the inflated level of the Euro the Eurozone is quite simply importing deflation.
Both the wider international environment and the current internal conditions within Europe are pushing the ECB down the same path as the FED and the BOJ but the problem faced by Draghi is rather more complex… While trying to manage investors’ expectations verbally is a relatively easy task with very little legal binding, unfolding a program with €1 trillion easing is a completely different animal.
During the last several days, rumours and speculation have been growing about a new €1 trillion quantitative easing program waiting in the wings at the ECB, but the truth is that there appears to be no agreement inside the governing council regarding the specific features of such a measure. Jens Weidmann, for example signalled that there is still plenty to discuss before any action is taken. In my view, this kicks any QE program further down the road.
Ewald Nowotny similarly indicates that such a program should target private securities instead of public debt. There are in fact so many legal problems related to public bond buying that targeting public debt may actually be out of question for now.
Now, just imagine for a moment that the legal issues re the ECB monetising debts are overcome. Which debt would it most likely be buying? If a decision to allow the ECB to buy sovereign debt in proportion to the size of its member countries were implemented, then it would result in the accumulation of debt from Germany and France in the largest proportion. I don’t really see that happening. Firstly because it would have a much reduced impact relative to the cost and second, because it would be a political issue. Alternatively, it is proposed that the ECB is more likely to buy debt from the more indebted European countries. Of course such a measure would likely act as an incentive for the respective governments of these countries to further spend and so undermine prior efforts to deleverage.
So, with public debt buying being somewhat difficult to follow (at least in the short run), it looks likely that the path of private debt buying will be trodden. Of course, buying €1 trillion in private debts is a little like going to your local supermarket and attempting to buy £1 million in fresh fruit and vegetables. Good luck with that!
QE in Europe is deemed to fail as a short-term project in my opinion as the issues to surpass the big legal and political difficulties are too difficult to overcome. Only an outright descent into serious deflation will prompt Draghi to follow his friends at the BoJ & Fed in my opinion.
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